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Catch Cloud with These ETFs

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The technology sector has been a decent performer this year with Technology Select Sector SPDR ETF XLK gaining 10.7% (as of October 20, 2016). A modest recovery in the U.S. economy, a solid IPO market especially in the second half and moderate earnings growth have been its drivers. Excluding the impact of the expected underperformance of Apple, the rest of the tech sector in the S&P 500 index is expected to see earnings growth of 4.5%.

Investors should note that among several corners of the sector, we see cloud computing marching ahead (read: Time to Buy These Tech ETFs?)

A Look at the Cloud Computing Segment

Against such a backdrop, it is warranted to have a closer look at the cloud computing segment of the broader technology sector. Cloud computing is a procedure by which data or software is stored outside a computer, but can be easily accessed anywhere/any time via the Internet. This process is gaining traction as it can cut IT costs of companies by removing expensive servers and trimming maintenance staff.

As per IDC, total spending for cloud environment, both private and public, will total $37.4 billion in 2016. That's an additional 0.7% increase from its 15.5% estimate at the end of the second quarter.

For the long term, IDC expects infrastructure related to IT-used cloud environments to expand at a compound annual growth rate (CAGR) of 13.6% to $60.8 billion in 2020. This marks about 49.7% of the total spending on enterprise IT infrastructure. On the other hand, spending on non-cloud IT will likely continue to fall at 1.8% annually during the same period.

Q3 Earnings Clearly Shows the Height of Cloud

Microsoft’s (MSFT - Free Report) shares hit an all-time high after hours on October 20 on better-than-expected earnings which was mainly backed by cloud-computing businesses. Microsoft’s Azure public cloud saw revenues skyrocket 116% year over year, or 121% in constant currency in the September quarter. Notably, Azure stands second in public cloud followed by Amazon Web Services (AWS).

IBM also benefitted from the cloud business which surged 44% in Q3 compared with a 30% rise in Q2. With this, IBM reported the “smallest drop in quarterly revenue in over four years.” Even Netflix NFLX which saw a blowout earnings in Q3, resorted to cloud architecture that allowed it to fast expand services to millions of subscribers (read: Buy These ETFs on Netflix Blowout Q3 Earnings).

All these give cues of a strong trend in the space. Investors must be interested in knowing how other stocks might perform throughout the reporting cycle. For them, we have highlighted our earnings prediction for some of the holdings of First Trust ISE Cloud Computing Index Fund SKYY (see all Technology ETFs here).

Inside Surprise Prediction

NetApp NTAP is SKYY’s second holding with 5.04% exposure. It has a Zacks Rank #3 (Hold) and a VGM score of ‘A’. Plus, its Zacks Industry Rank is within the top 10%. The company is expected to report on November 16 and has an Earnings ESP of +2.63%.

Our proven model conclusively shows that NetApp is likely to beat on earnings since a stock needs to have both a positive Earnings ESP and a Zacks Rank of #1, 2 or 3 for an earnings beat to happen.

The king of cloud, Amazon AMZN takes 4.18% of SKYY. It has a Zacks Rank #1 (Strong Buy) and an Earnings ESP of +6.98%. This ensures higher chances of a beat. The company is expected to report on October 27.

Alphabet Inc. GOOGL grabs about 4.14% of SKYY. It has a Zacks Rank #2 (Buy) and an Earnings ESP 0.00%. The company is expected to report on October 27. It has a VGM score of ‘C.’

The fund’s fourth holding is NetSuite N with 4.62% focus. Its industry rank is in the top 44% at the time of writing. However, the stock has a VGM score of ‘D’ and an Earnings ESP of 0.00%. The stock has a Zacks Rank #3.

Bottom Line

Overall, the Earnings ESP picture for the upcoming releases is bullish-to-decent. But investors should note that SKYY has a Zacks ETF Rank #2 with a moderate risk outlook. So, for investors keen on playing this thriving cloud computing space, the time is ripe for building a position in SKYY.

Investors can also get in touch with cloud computing by investing in ETFs like iShares U.S. Technology ETF IYW, XLK, Vanguard Information Technology ETF VGT and PowerShares NASDAQ Internet ETF PNQI. These ETFs have heavy exposure to stocks dealing with cloud business.

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